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Wednesday, May 29, 2013

Managing Lender Liability in Equator Principles Implementation - Third Party Beneficiary Rights in Contract Law

I read an interesting and provocative journal article by Marissa Marco, published in the Fordham International Law Journal in 2011, entitled "Accountability in International Project Finance: The Equator Principles and the Creation of Third-Party Beneficiary Status for Project-Affected Communities".  The article discusses the law on third party beneficiary rights under US contract law and considers whether the provisions of the Equator Principles (EP) relating to Affected Communities might create enforceable rights for those communities under those principles.

This article will discuss this issue and suggest a risk management strategy for EP Financial Institutions (EPFI - i.e. EP signatories) addressing and managing such risks in Equator Principles implementation.

There is a presumption in the English and United States common law systems that contracts are a private arrangement intended to be enforceable between the parties to the contract. This concept is referred to as "privity" of contract, which prevented third parties from obtaining benefits or having responsibility for the terms and conditions of a contract that they were not a party to.

While this limits third party rights under contract, there are numerous possible avenues for third parties to enforce their rights vis-a-vis contracting parties. The most obvious source for third party rights is through "tort" law, which creates free standing rights (i.e. not tied to contractual terms) for third parties regarding the acts of persons (including companies) that owe the person what is called a "duty of care" to the third party.  For example, while a contract to deliver a product may be between a retailer and an end-user, if that product is defective and it injures the end-user there may nevertheless be recourse for the for the injured person against the manufacturer of the product. This is even though there was never a contractual relationship between the end-user and the manufacturer.

A less well known source of rights and obligations is the "third party beneficiary" right that can arise under certain contractual arrangements, including lender-borrower contracts.
Law of the United Kingdom on Third Party Beneficiary Rights

The law in the United Kingdom for example (a legal regime often applied to international financing documents) on third party beneficiary rights is largely defined by a statute called the Contracts (Rights of Third Parties) Act 1999 (the "RTP Act")Generally speaking, the RTP Act changed the law on third party beneficiary rights, and allows a third party to a contract to enforce rights under the contract where:

  1. The third party is specifically mentioned in the contract as someone authorised to enforce rights under the contract, or;
  2. The contract "purports to confer a benefit" on the third party. 
Importantly, the third party must either be identified by name or as a member of a particular group in the contract itself, although the person or group need not exist when the contract was made. The RTP Act creates restrictions on how the contracting parties can amend a contract to remove third party benefits, particularly where the third party has relied on those rights. Improper removal of third party rights could give rise to a claim for damages by the third party.

Where third party rights exist, the third party could be entitled to sue to enforce the contract, including requesting monetary damages or even specific performance of contractual obligations.

Examples from the US Context

The law in the US is discussed in detail in Marissa's paper, but it is not dissimilar to the UK law, with "intention" to confer a benefit on a third party being critical to a finding of a third party beneficiary right.  Marissa discusses some interesting case examples where this right has been found that has profound application to the implementation of the Equator Principles.

For example, the case of Chen v. Street Beat Sportswear, Inc. (the "Chen" case) is discussed as a useful illustration of the third-party-beneficiary rule. Chen involved a suit against a domestic clothing manufacturer, Street Beat Sportswear, Inc., by its workers who alleged that they were third- party-beneficiaries of a contract between the defendant and the Department of Labor ("DOL").

Through this contract, the defendant had entered into an Augmented Compliance Program Agreement ("ACPA"), which required the defendant to review, monitor, and report on its contractors' compliance with the US Fair Labor Standards Act.

Applying the three-pronged test under New York law, the court agreed with the plaintiffs' contract claim. The court reasoned that the parties' intent to benefit the plaintiffs was clear from the ACPA because every provision to evaluate and monitor factories was for the sole purpose of protecting the factory workers. Thus, the court rejected the argument that the ACPA was only evidence of intent to benefit the contractors, rather than the workers. In addition, the court disagreed with the argument that the plaintiffs were merely incidental beneficiaries, noting that intent may be established either by demonstrating that only the third party would recover or by the express language of the contract.'

Although the language of the ACPA provided for a recovery only by the DOL, the court rejected the assertion that the parties never intended to permit enforcement by outside parties.' Though the ACPA was silent on the issue of enforcement by third parties, the intent to benefit the plaintiffs could be interpreted from the contract as a whole. The court also found that the third requirement of a "sufficiently immediate" benefit had been satisfied. Because the ACPA required the defendant to evaluate and report on violations and to compensate workers within a specified period, the court found the scheme to be sufficiently immediate. Ultimately, the court held that the plaintiffs were the intended beneficiaries of the ACPA, the parties had specific intent to benefit the plaintiffs and, as a result, the plaintiffs had standing to sue for breach of the contract. compliance with the Fair Labor Standards Act.

In another fascinating case, Jane Doe v. Wal-Mart Stores, Inc., the company's published code of conduct and alleged failure to comply with the code led non-US plaintiffs to file an action against Wal-Mart in California. The plaintiffs were employees at factories in Bangladesh, China, Indonesia, Nicaragua, and Swaziland that supplied products directly to Wal- Mart.' Wal-Mart's code of conduct, which was expressly part of the contract between Wal-Mart and its supplier factories, required that all suppliers comply with local labor laws and allow Wal-Mart to audit the factories to ensure compliance with the code.'

The plaintiffs argued that because the code was for the benefit of the workers, Wal-Mart's contract with their employer provided them with third-party-beneficiary status and standing to sue Wal-Mart for failing to enforce the standards.

Both the United States District Court for the Central District of California and the Ninth Circuit Court of Appeals disagreed with the third-party-beneficiary claim for two reasons:

  1. First, Wal-Mart's reservation of rights to inspect the suppliers' factories did not amount to a promise by Wal-Mart to uphold its code of conduct.
  2. Second, the court noted that a promise creates a duty of performance in the promisor, not the promisee. Because the Wal-Mart contracts required a promise by the supplier to comply with local labor laws, Wal-Mart was in fact not the promisor - rather, the suppliers were the promisors.' Thus, the plaintiffs sought performance from the incorrect party to the contract. Because the plaintiffs did not allege sufficient facts to show third-party-beneficiary status, the court dismissed the plaintiff's claim.
Application to the Equator Principles

The foregoing principles and cases are very important for consideration in the context of the Equator Principles and the issue of Lender (or borrower) liability for EP implementation.  The question is begged, could Equator Principles terms and covenants which are incorporated into the contractual documentation underpinning an EP financing give rise to third party beneficiary rights? These are not easily answerable questions and require special attention in the implementation of the EP by EPFI and their borrowers.

For example, a recent Facility Agreement draft I reviewed for a Category A EP project, applying UK law, dealt with third party beneficiary rights by reference to the RTP Act and contained no express limitations on third party rights that may arise from the application of the Equator Principles.  I flagged this as an issue for further consideration, in light of the foregoing principles. This highlights the fact that precedent agreements of EPFI may not have clearly addressed this issue, despite the possible liabilities that exist.

The avenue for third party beneficiary claims under the EP is quite evident. It derives from the express statements found in the EP itself, which are incorporated by reference into most contractual documents structuring EP financings.

For example, the preamble language of the new EP III states:

"Large infrastructure and industrial Projects can have adverse impacts on people and on the environment. As financiers and advisors, we work in partnership with our clients to identify, assess and manage environmental and social risks and impacts in a structured way, on an ongoing basis.

Such collaboration promotes sustainable environmental and social performance and can lead to improved financial, environmental and social outcomes. We, the Equator Principles Financial Institutions (EPFIs), have adopted the Equator Principles in order to ensure that the Projects we finance and advise on are developed in a manner that is socially responsible and reflects sound environmental management practices. We recognise the importance of climate change, biodiversity , and human rights , and believe negative impacts on project - affected ecosystems , communities , and the climate should be avoided where possible . If these impacts are unavoidable they should be minimised, mitigated, and/ or offset .

We believe that adoption of and adherence to the Equator Principles offers significant benefits to us , our clients, and local stakeholders through our clients’ engagement with locally Affected Communities . We therefore recognise that our role as financiers affords us opportunities to promote responsible environmental stewardship and socially responsible development , including fulfilling our responsibility to respect human rights by undertaking due diligence in accordance with the Equator Principles . 

The Equator Principles are intended to serve as a common baseline and framework . We commit to implementing the Equator Principles in our internal environmental and social policies, procedures and standards for financing Projects . We will not provide Project Finance or Project - Related Corporate Loans to Projects where the client will not , or is unable to, comply with the Equator Principles. As Bridge Loans and Project Finance Advisory Services are provided earlier in the Project timeline, we request the client explicitly communicates their intention to comply with the Equator Principles." 

As this preamble language clearly states, the EP is seen by EPFI to "offer significant benefits" to "local stakeholders".  As well, many of the substantive requirements of the EP, the IFC Performance Standards and EHS Guidelines are drafted with the clear purpose of protecting the rights of stakeholders affected by the environmental and social impacts of a project. This is particularly evident, for example, in the language of Performance Standard 2 pertaining to Labor and Working Conditions and Performance Standard 7 pertaining to Indigenous.  Performance Standard 2 is drafted to confer rights on workers that they might not otherwise be entitled to by local laws.  Similarly, Performance Standard 7 confers rights of consultation and even Free Prior and Informed Consent of Indigenous Peoples communities that may go beyond legal consultation requirements. While the EP was likely not intended to be legally enforceable by third parties like workers or Indigenous communities or otherwise Affected Communities or local stakeholders, the implication of the legal principles discussed suggests there is a risk this might be possible.

This possible risk is particularly heightened since the language and requirements of the Equator Principles, including this preamble and substantive requirements of the IFC Performance Standards and EHS Guidelines, are expressly incorporated into the terms and conditions of an Equator Principles loan or financing. Unfortunately, the wording of the EP goes beyond and may therefore be distinguishable from the type of commitments to merely "audit" that were found in the Wal-Mart case (noted above). This could create enhanced risks for EPFI that their commitments in relation to the EP could be found to confer a benefit on third parties, who may then be entitled to enforce such commitments as third party beneficiaries. 

As well, if financing contracts do not specifically address this issue, the application of the common law or statute (which looks only to the intent to confer a benefit expressed in the actual wording of the contract - rarely considering "extrinsic" evidence like the testimony of those who drafted it) could easily result in a finding of EPFI or borrower obligation in relation to a third party to the contract.

Strategies for Addressing Third Party Beneficiary Rights Risks

This issue presents a difficult legal problem for EPFI, since many of their EP related financing contracts may not have addressed this issue adequately when they were originally drafted. This could mean there are substantial liability risks on EPFI books that a prudent EPFI may wish to assess and deal with. These issues should also be dealt with on a going forward, by EPFI reviewing their practices in implementing EP III, which takes effect June 4, 2013.

Some strategic considerations in dealing with these issues include:
  1. Considering how past agreements can be revised (taking into account restrictions on removing or rescinding third party beneficiary rights) to address the risk that third parties may have rights to enforce EP commitments under contractual terms;
  2. Consider revising third party beneficiary language in EP related contracts, on a going forward basis, to ensure that third party beneficiary rights are expressly excluded, to reduce the possibility that there is an inference of such rights should a claim be made;
  3. Consider how indemnities can be used to shift monetary consequences of third party claims from EPFI onto borrowers, who are ultimately responsible for managing environmental and social issues;
  4. Ensure legal oversight of public reporting and stakeholder engagement and consultation activities, to ensure the risks of third party beneficiary rights is effectively managed as part of that process.
These strategies emerge from a high level consideration of this issue. EPFI may be well advise to seek advice on what unaddressed risks they may already have on their books, and the best methods for dealing with them.

Should you have any questions about this issue or wish to discuss further please contact me at

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